The Green Sheet Online Edition

July 11, 2016 • Issue 16:07:01

The Consumer Financial Protection Bureau wants to rein in payday lending. Will merchant cash advances be next? Probably not, but alternative lenders serving the small business market are not entirely off the hook. The CFPB has broad authority for enforcing consumer credit laws, most notably the Truth-in-Lending Act. It also has initiated legal proceedings against payment processing firms found to be running transactions for consumer scams.

In June 2016, the CFPB published a regulatory proposal that would require payday lenders and other companies making collateralized short-term loans to consumers to think and act more like banks and credit unions.

The proposal, which is being challenged in Congress, would require these lenders to make reasonable determinations of each applicant's ability to repay, taking into account the consumer's living expenses and verifying income, for example. And it would curb sequential loans: no loans would be permitted to individuals who have received other short-term loans within the past 30 days.

Payday loans have existed since the 1980s but really began to take off when banks pulled back on lending following the 2008 financial meltdown. By 2014, there were 20,000 payday lenders (online and storefront businesses) nationwide, according to the Federal Reserve Bank of St. Louis. In addition, thousands of companies (online and brick-and-mortar) offer auto-title loans and similar collateralized small-dollar, short-term loan instruments.

"Too many borrowers seeking a short-term cash fix are saddled with loans they cannot afford and sink into long-term debt," CFPB Director Richard Cordray said in announcing the proposal. "By putting in place mainstream, common-sense lending standards, our proposal would prevent lenders from succeeding by setting up borrowers to fail."

The CFPB's proposal, which runs about 1,300 pages, takes aim at what the bureau describes as "debt traps" by requiring lenders to make upfront determinations of whether borrowers will be able to repay their loans without re-borrowing. The proposal would, in effect, create a national standard for regulating payday lending, which today is primarily governed under a patchwork of state laws.

A report issued in June 2016 by Democrats on the U.S. House Financial Services Committee details how many payday lending-type businesses skirt state regulations, thereby making a case for federal oversight. "What this report tells us is that even in states that have attempted to curb abusive payday lending harmful practices still exist," said Rep. Maxine Waters, D-Calif., the committee's ranking Democrat. "That's why we need a strong and effective national standard that will protect all Americans."

Concern for consumers in 'debt traps'

In a statement, the CFPB said the proposal grew from "serious concerns" about consumers who unwittingly incur debts they cannot afford to repay. And it released a report of its own, detailing extensive research on payday and auto title loans. Here are some highlights:

The average loan from a payday lender is $1,291. The typical fee paid is $15 for every $100 borrowed, and the typical loan term is 14 days.

The median annual percentage rate on payday loans in 249 percent; the median APR for a vehicle-title loan is 259 percent.

Four out of five payday loans are rolled over within 30 days, incurring additional charges with each renewal.

Payday borrowers end up in default about 20 percent of the time. Nearly half of defaults occur when a consumer re-borrows three or more times.

Payday lending has been on the CFPB's radar since the bureau's earliest days. Its first-ever field hearing, hosted by the bureau in 2013, was to gather information and input on the payday lending market. It was there that the CFPB disclosed that its examiners would be looking closely at payday lending by banks and nonbanks alike.

What about MCAs?

The business of making merchant cash advances (MCAs), which are typically collected from credit and debit card receivables, has followed a growth trajectory similar to that of payday loans, both of which spiked in the post-2008 bank credit crunch. The proliferation of MCA businesses has provoked concerns, with some opponents likening them to payday loans.

In May, The U.S. Department of the Treasury released a white paper that examines the online lending market, detailing risks as well as benefits of this evolving market. The paper, which distills responses to a request for information earlier this year, pointed to uneven protections for small business borrowers. "RFI commenters across the stakeholder spectrum argued small business borrowers should receive enhanced protections," the white paper states.

Meanwhile, legislation recently approved by a committee of the Illinois state legislature would subject MCAs and other small-dollar, short term business loans to "transparency standards" like those that already cover highly regulated lenders (such as mortgage companies and banks). Supporters said the legislation was crafted in response to growing complaints from small business owners about burdensome loans. "Too often we're seeing instances where hard-working entrepreneurs are being preyed upon by a growing number of unscrupulous lenders," the bill's sponsor, State Senator Jacqueline Y. Collins, D-Chicago, said in a statement.

Steve Denis, Executive Director of the Small Business Finance Association, doesn't see the CFPB coming after MCAs and similar nonbank lenders the way it has payday lenders. Neither does attorney Adam Atlas. Both noted that the Dodd-Frank Act, which created the CFPB, precludes the bureau from taking legal actions against small-dollar commercial lenders.

"In most cases, financing providers to business are given greater freedom because businesses are not in need of government protection and actually need greater flexibility in their selection of financing options," Atlas said.

Denis pointed out that there is "a huge difference" between consumer lending and business loans. "Some regulators want a one-size-fits-all legislative approach," he said. "I don't think they fully understand how this platform works." Denis noted that MCA companies and other alternative lenders are committed to helping small businesses left behind by banks to obtain credit and build their businesses. That's why the SBFA recently published a set of best practices for these companies to follow.

"The financial technology industry is creating innovative products every day to meet an underserved need for small businesses," Denis said. Jeremy Brown, Vice President of the SBFA and Chairman of RapidAdvance, added, "These best practices are our way to prove to small businesses that our industry will consistently offer transparent, fair and responsible choices to meet their needs."

Patti Murphy is Senior Editor of The Green Sheet and President of ProScribes Inc. She is also the founder of InsideMicrofinance.com. Email her at patti@greensheet.com.

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